Interesting to read the venerable

href="http://www.ft.com/cms/s/0/802a9912-35ff-11e1-9f98-00144feabdc0.html#axzz1iO7ZgYxH"

target="_blank">Leo Melamed's open letter in the FT

this week on HFT and regulators. The CME's chairman emeritus

certainly makes a good point when he says that trying to stifle

innovation is both wrong and inevitably doomed to failure, but I

am not sure he's completely right in a couple of areas. First,

whilst it's true that algorithmic or HFT players have indeed had

the effect of narrowing spreads, this is not always the best

thing for the trading community as tighter spreads are nearly

always associated with smaller trade sizes. This is a particular

problem for the institutional buy-sides wishing to trade in size.

A colleague at one such buy-side firm compared HFT to a waiter

who, rather than serve a meal in three sensible courses, insists

on bringing it to you in small spoonfuls and stays at your table

waiting for a tip before he will go back to the kitchen for your

next morsel.

Also, I imagine that most

regulators would see themselves as gamekeepers rather than

poachers but this does help highlight the fundamental problem our

industry faces. The minute you interfere in any ecosystem and try

to protect one species or another you invariably invoke the law

of unintended consequences. This is especially true in financial

markets that are going through a rapid period of evolution driven

by a technology-inspired natural selection process. The tendency

then is to try and adjust for these consequences with yet more

regulation and so the vicious cycle continues. This is confirmed

by the fact that it was the regulators themselves that

inadvertently fuelled the HFT boom by breaking up the national

(natural?) monopolies of stock exchanges in the first

place.

We begin 2012 much as we left 2011 with

fear, uncertainty and doubt being the prevailing sentiments, so

maybe regulators on both sides of the Atlantic should take a

second look at their groaning inboxes. Perhaps a return to

lighter touch regulation is the lesser of two evils. Why not let

the natural evolution of financial markets play itself out. Of

course, there will be individual winners and losers but the

overall ecosystem will emerge stronger to the benefit of

everybody who is either directly or indirectly affected by

capital markets. The alternative will be ever-growing mountains

of retrospective regulation that will be arbitraged, hidden

behind or simply never understood.